U.K. Stripped of AAA Rating by Moody’s Amid Outlook Weakness

Feb. 23 (Bloomberg) -- Britain lost its top credit rating
by Moody’s Investors Service, which cited weakness in the
nation’s growth outlook and challenges to the government’s
fiscal consolidation program.

The rating on the U.K. was lowered one level to Aa1 from
Aaa and the outlook on the nation’s debt changed to stable from
negative, Moody’s said in a statement yesterday. With the U.K.’s
high and rising debt burden, deterioration in the government’s
balance sheet is unlikely to be reversed before 2016, Moody’s
said in the statement.

“We don’t expect much market impact from the downgrade, it
was widely expected,” David Tinsley, an economist at BNP
Paribas SA in London, said today in an e-mail. “The bottom line
is that the U.K. needs to find some growth to raise tax
revenues.”

The cut will increase political pressure on Chancellor of
the Exchequer George Osborne, with the opposition Labour Party
calling on him to scale back his fiscal squeeze as the economic
recovery struggles to gain traction. The U.K. economy shrank 0.3
percent in the fourth quarter of last year from the prior three-month period, leaving the country on the brink of an
unprecedented triple-dip recession.

The pound fell after the downgrade in the last half-hour of
trading in New York, dropping 0.6 percent to $1.5163. Sterling
has depreciated 5.6 percent this year, the second-worst
performer after the yen among 10 developed-market currencies
tracked by Bloomberg Correlation-Weighted Indexes.

Bond Yields

The U.S., France and Japan “have not paid up because of
downgrades and it is unlikely that the bond market will be where
the U.K. feels the most pain,” said Steven Englander, head of
G-10 currency strategy at Citigroup Inc. in New York.

Yields on sovereign securities moved in the opposite
direction from what ratings suggested in 53 percent of 32
upgrades, downgrades and changes in credit outlook last year,
according to data compiled by Bloomberg published in December.
Investors ignored 56 percent of Moody’s rating and outlook
changes and 50 percent of those by Standard and Poor’s. That’s
worse than the longer-term average of 47 percent, based on more
than 300 changes since 1974.

Slow U.K. Growth

While the U.K. retains “considerable structural economic
strengths,” expected slow growth of the global economy and the
reduced speed of debt reduction in the country led to Moody’s
decision, the company said in the statement.

“Tonight we have a stark reminder of the debt problems
facing our country -- and the clearest possible warning to
anyone who thinks we can run away from dealing with those
problems,” Osborne said in a statement in London. “Far from
weakening our resolve to deliver our economic recovery plan,
this decision redoubles it.”

Britain’s debt as a percentage of gross domestic product
will climb to 98 percent next year from 90 percent last year and
95.4 percent in 2013, the European Commission said in its winter
forecast yesterday.

Further Downgrades

The downgrade “comes as little surprise,” Tinsley at BNP
Paribas commented. “The U.K. has a similar gross debt to GDP
ratio as France and the U.S., both countries who have lost their
AAAs in recent history.” Tinsley expects Fitch to downgrade the
U.K. “shortly after the March Budget,” and S&P will probably
follow.

Moody’s cut France’s country’s top rating on Nov. 19 by one
level. S&P lowered the rating by one step to AA+ from AAA on
Jan. 13, 2012. Yields on the nation’s 10-year bonds have climbed
16 basis points, or 0.16 percentage point, since the Moody’s
downgrade. The borrowing cost has declined 84 basis points since
the S&P cut. Moody’s also downgraded from Aaa Ireland in 2009
and Spain in 2010.

U.S. Treasuries rallied after Standard & Poor’s stripped
the U.S. of its top ranking on Aug. 5, 2011, with yields
touching a record low 1.379 percent in July 2012. U.S.
government debt gained 9.8 percent in 2011, the most in three
years, according to Bank of America Merrill Lynch index data.

Austerity

“This is an era where developed countries are being
downgraded on a regular basis,” said Eric Lascelles, chief
economist for RBC Asset Management in Toronto.

Osborne’s austerity policies will squeeze the budget
deficit to 6 percent next year from 10.2 percent in 2010, when
his Conservatives took over in an unprecedented coalition with
the Liberal Democrats, according to the predictions by the
commission.

“Because of the combination of weak growth outlook,
substantial fiscal challenges, high and rising debt burden, and
the deterioration in shock absorption capacity, we see that the
credit worthiness of the U.K. has deteriorated to a level that
is more commensurate with Aa1 rating,” Sarah Carlson, a senior
credit officer at Moody’s in London, said in a telephone
interview.

Osborne said in his autumn statement Dec. 5 that he’s no
longer likely to meet his target to begin cutting the burden of
government debt in 2015-16 after his fiscal watchdog cut its
growth forecasts. S&P put the U.K.’s rating on a negative
outlook a week later.

Fitch Ratings said on the day of the budget that missing
the debt target “weakens the credibility of the U.K.’s fiscal
framework.” It will conduct a further formal review of the
rating in 2013 incorporating the budget, due March 20. Fitch
lowered its outlook on the U.K. to negative from stable in March
2012. Moody’s lowered its outlook the previous month.